Capitalizing Vs. Expensing Costs
Management typically has some discretion in determining if the cost of an item should be capitalized to the balance sheet and depreciated (or amortized if it is an intangible asset) to the income statement over time or if the cost of the item should be fully expensed to the income statement in the current period. In general, any expenditure that is expected to provide economic benefits for multiple accounting periods should be capitalized.
When a cost is capitalized, it is reported in the balance sheet as an asset. The cost is then allocated to the income statement over multiple periods as depreciation expense for tangible assets and amortization expense for intangible assets.
On the other hand, if a cost is expensed in the current period, it reduces the pre-tax income by that amount.
Once an asset has been capitalized, any more expenditure related to the asset that will increase its useful life will also be capitalized. However, any expenditure that helps the company maintain the asset will be expensed to the income statement.
Example
Let’s take an example. Suppose a firm purchased new machinery for $100,000. This amount includes the freight and taxes. After that the company spent $5,000 to install the machinery and another $2,000 was spent on training the staff. Every year the company spent $3,000 for maintenance of the machinery. After 5 years, the company spent $25,000 on the machinery that helped the company in extending the life of the equipment. The following table summarizes which costs are capitalized and which ones are expensed.
| Cost | Capitalized | Expensed |
| Purchase cost - $100,000 | Yes | |
| Installation - $5,000 | Yes | |
| Training - $2,000 | Yes | |
| Maintenance - $3,000 | Yes | |
| Rebuilding - $25,000 | yes |
Impact on Financial Statements
The following table provides examples of the effects on a company’s financial statements and ratios when expensing in-year versus capitalizing in-year.
| IMPACTED ITEM | EXPENSING | CAPITALIZING | Remarks |